Industrial Policy Reconsidered

[ I’ve always been a skeptic of industrial policy, and the travails of the various federal green programs and such make me feel justified my thinking in that regard. Yet, for struggling communities, clearly something needs to be done, even if not trying to pick specific winners and losers. In 1983 Rhode Island had an opportunity to have implemented an economic turnaround plan dismissed by critics as industrial policy, but voted it down. I recently took a look back and that, and the results of that decision that I think are relevant to other places trying to figure out what to do or not do. ]

I’m a relative newcomer to Rhode Island, but you don’t to be here long to hear about the infamous “Greenhouse Compact,” a state economic development strategy developed at the end of the Volcker recession in 1983 and voted down by the public in 1984. It is certainly one of the most remarkable economic development analyses ever performed. I have not seen a full copy, but the internet tells me it exists in at least two volumes with a length of at least 976 pages. There was a 47-page executive summary — not much shorter than many full reports these days — that I did manage to get ahold of and read, however. If the full report is as robust as that suggests, then I’ve never seen anything that appears to be so thorough and in-depth.

The Greenhouse Compact vs. Laissez-Faire

The Greenhouse Compact was the brainchild of Ira Magaziner, who went on to design Hillarycare, apparently not learning his lessons as that plan was developed and failed in a similar fashion. Though perhaps not the reason the Greenhouse Compact was voted down, it was roundly criticized by economists like Brown’s Allan Feldman, who strongly attacked it as industrial policy.

Magaziner and Feldman lay out starkly contrasting views of the matter. The Greenhouse Compact says:

Today, Rhode Island is in an economic crisis….When an economy has a vibrant private sector which can clearly provide the growth opportunities in investment that the economy needs to employ its people fully and raise its living standards then one can speak of a laissez-faire attitude as being appropriate. Rhode Island is currently far from that. It has many industries which are becoming subject to low wage competition; it has many others which are mature low wage rate industries with very little growth prospect but a need to modernize and develop new products; it has very few companies that have the prospect for significant growth and these are often being wooed by other states with particularly attractive incentive packages; and it has only a smattering of activities in new technology areas. Under these circumstances, a concerted economic development effort is the only way to create the momentum to build economic prosperity.

“I think this is not an appropriate thing for government to do, but that’s not my basis for opposition,” said Allan Feldman, an economics professor at Brown who is co-chairman of a group, Common Sense, formed to oppose the Greenhouse Compact. ”Beyond the ideological question, I think the economic analysis is terrible and the plan won’t work. It favors bankers, venture capitalists and high technology, and while it might be great for Terry Murray’s bank, it won’t help the average Rhode Islander.”

After it was voted down, he said in the Christian Science Monitor, “It was not economically sound, and would ‘offer very little to taxpayers.’” He also wrote an article in which he gloated that “industrial policy is dead.”

A bit later, as Rhode Island’s economy was looking up, Feldman appeared vindicated, telling the Washington Post in an article titled “Rhode Island: Rags to Riches”, “Governors delude themselves. They like to think they’re responsible for everything.” In the same piece Magaziner stuck to his guns, saying, “We should be fixing the roof when the sun is shining. We really should have invested more than we have.”

The Greenhouse Compact Vindicated

Fast forward 30 years and what has history shown? The predictions of the Greenhouse Compact have been entirely vindicated and the approach of Feldman and company has perpetuated the economic ruination of the state. Rhode Island’s post-recession bump wasn’t a real recovery; it was a dead cat bounce.

The Greenhouse Compact had said, “Overall, prospects are bleak. Industries which are likely to lose employment or at best stay stable far outweigh those with growth prospects. Those companies with growth prospects often plan to expand out of state….Given the current structure of Rhode Island’s economy, these jobs are unlikely to emerge.” This report included a sector by sector analysis in which it concluded that with the exception of eds and meds, the future didn’t look bright. And while it may have been off in some details, clearly history has borne out the Compact’s central claims.

It certainly possible that the Greenhouse Compact’s recommendations would have failed to stem the tide. But it’s hard to see how they could have made things much worse, thus pursuing the strategy likely made sense on option value alone.

What Feldman and the ultra-purists on the right fail to fully recognize is that creative destruction is real. Just as in the commercial marketplace where almost all firms ultimately fail, the vast majority of places will end up failing as well. Once they reach the top of their maturity curve, they’re done, and unless they reinvent themselves and begin a new growth curve again, they sicken and enjoy a long stagnating decline. Rhode Island reinvented itself three times from agriculture to seaborne merchant trading to industry, but failed to pull-off a fourth reinvention. Any CEO of a company facing a similar need to reinvent itself certainly would not take the attitude that he should let the market sort it out and do nothing but manage costs. But that’s the prescription too many give to public sector leaders.

From ‘Industrial Policy’ to ‘Conventional Wisdom’

Not all of the Greenhouse Compact’s recommendations make sense. The $138 million (a lot more than that now when you factor in inflation) in incentives to existing industries seems more like a fillip to interest groups to secure their buy in than a real strategy, for example. But a lot of it, including the eponymous “greenhouse” component, were ahead of their time and indeed have become almost conventional wisdom.

The Greenhouse idea was to basically have some public sector support to nurture emerging industries that were research and technology related in areas where Rhode Island was perceived to have some potential to play. These would include a marketing and civic booster program, as well as a venture capital fund, including some unique components such as allowing the state’s pension fund to invest in startups.

Pretty much every state has adopted a similar model in the last decade. Even Tea Party friendly politicians like Indiana Governors Mitch Daniels and Mike Pence invested heavily in Biocrossroads, which is the umbrella organization for that state’s “greenhouse” in life sciences, for example. They may be fiscal conservatives, but they’re not dumb. Pretty much every single city and state has variations on these. Another example: one of the plan’s suggestions was to create a Rhode Island Academy of Science and Engineering to boost the supply of talent into those industries. This idea was recently implemented — by New York Mayor Michael Bloomberg, who is opening a new technical and engineering college on Roosevelt Island in conjunction with Cornell and Israel’s Technion backed up by significant public investment. Look at any city or state, and you’ll see them trying some variation on the greenhouse theme, though with different terminology. Many of these programs are ‘me too’ initiatives that aren’t likely to be effective. But where the approach is applied to areas where a state or metro area has a potential advantage, it makes a lot of sense.

It’s interesting that the Greenhouse Compact even specifically warned against 38 Studios style cross-border raiding, saying, “To some states, economic development has meant trying to convince industries in other states to close down and move. This will not be Rhode Island’s approach. We are not interested in ‘stealing’ another state’s companies.”

Now plans aren’t implementation, and obviously the reality would have involved a lot of politicization. I’m not so naÃ¯ve to believe that poaching attempts would have been eliminated just because this report said so. But the bottom line is that Rhode Island had an opportunity to be 20 years ahead of its time, and took a pass. Free market types might argue that their preferred policies were never implemented either, but that’s the right-wing equivalent of “true communism’s never been tried.” The results are in and the Rhode Island experience makes it very clear that while some of these approaches that might have had aspects of industrial policy (though certainly nothing like the botched federal green subsidies and such that rightly give industrial policy a black eye) may not have been the right idea, doing nothing certainly didn’t work.

In a lesson to Tea Partiers everywhere, the Greenhouse Report summed it up, “If Rhode Island is to undergo an economic renaissance, investors must have significant positive reasons for investing in this state rather than any other. The absence of negatives will not be enough.” A Tea Party style focus on nothing other than taxes and costs — removing the negatives — is insufficient and history has borne that out (just as is now being repeated in many Midwestern states that are becoming Rhode Islands despite their nominally attractive business climates). Want to oppose plans like the Greenhouse Compact? Fine, but show us your plan and give us a reason to actually believe it will work.

Based on what I read in the executive summary, though there area a number of anachronisms and areas I didn’t agree with, the Greenhouse Compact actually stands up quite well today. If it were simply implemented as is, it would still probably be an improvement over the status quo, but now that everybody and their brother has piled on, the big returns have, sadly, already been harvested elsewhere.

This article originally appeared in GoLocalProv on September 23, 2013.

Share This Post:

Related

Comments

Today, people are much smarter and many of them utterly cringe at the ominous industry-annihilating word “Greenhouse” (as visions of draconian business-strangling regulation conjure up to high heaven), the current pseudoscience of Eco-Wackos and politicized Global Warming-biased researchers and scientists (in name only) associated with it to instigate social engineering of the masses via fear tactics for carbon footprint profiting amongst the 1% Global-Eco-Elite, who have the biggest carbon footprints in the entire Universe. Perhaps a nomenclature might be considered if converts are to be seriously expected.

The problem with your analogy to reinvention is that you treat states and cities like companies, rather than like governments. Government industrial policy doesn’t work, because a government attempt to pick winners and losers will invariably involve massive amounts of corruption, even in the more successful cases (see e.g. anywhere in East Asia). In the countries where industrial policy co-occurred with fast growth, such as Japan and South Korea, either the fastest-growing industries were ignored by the industrial policy (e.g. cars in Japan) or geopolitical reasons permitted beggaring one’s neighbors (China’s currency manipulation, South Korea’s one-way free trade with the US). Corporations that engage in inefficient policy can die very fast because of competition. Governments do not.

On the level of subnational entities within a country, all the problems of national industrial policy are still there: straight corruption, revolving doors, resistance to strategies that just generally improve the business climate. But there’s an additional problem, which is that beggar-your-neighbor works because the economies are more open; the loss of economic efficiency coming from one town’s subsidies to Wal-Mart is outweighed by the benefit the town draws from sucking all the jobs from the nearby towns that didn’t get a Wal-Mart.

So what can look successful on the level of a single city or state is in fact destructive on the national level, and needs to be prohibited legally, just like it’s constitutionally prohibited for one state to levy tariffs on another. In fact the US Constitution was a highly successful free trade agreement, which banned the trade barriers that were known in 1787. In 2013, the mercantile politicians have more tools available, and therefore federal law needs to ban more than just tariffs. The EU’s enforcement of internal free trade is a good guide: even ostensibly neutral rules that de facto privilege one member state over the others are illegal, for example France’s attempt to charge tariffs on state-owned high-speed railroads by the car rather than by the passenger (SNCF uses bilevels, future competitors such as DB use single-level trains).

As for green jobs, I’m going to add this to my stack of posts on my to-do list, but You’re Doing It Wrong. The purpose of environmental policy is not to create jobs. It’s to improve the state of the environment. States need to understand that the reason to ban environmentally destructive practices is that their residents’ health is at stake, not that that those regulations could lure green investors in; policies aimed mainly at job creation, such as building marginal rail lines to compete for a tiny pool of transplant train factory jobs, will do a bad job at accomplishing environmental goals. It’s always easier to subsidize something than to take on large polluters, which like to say, “we may be killing people, but think of the jobs!”

Alon, I agree with everything you said. The key is, what then should be done?

It’s not enough to reject industrial policy, what’s the alternative. The right’s answer is: lower taxes and less government and the market will make it work. Point to Texas and things look great on that front (urban Texas at least). Mississippi is a different story. Tennessee has radically uneven performance throughout the state despite similar policies.

Most turnaround policies have basically failed. What’s the right path? I think education is a no-brainer. But not a panacea. I frequently argue quality of place is important today. But clearly there needs to be something as most failed places have not spontaneously recovered. (Though certainly the market itself will revive some).

I would argue that there has always been an industrial policy. Industrialization doesn’t happen without a policy. The very beginning of the industrial revolution began with the British government’s attempts to maintain the best navy in the world and inventing interchangeable parts. America’ formal policy through most of the 19th century was the clear the land of the tribes and replace them with farms and mines. The construction of huge “internal improvements” as they were known such as the Erie Canal and the Chicago canals opened up the interior of America to industrialization. Tariff and trade policy was geared towards industrialization. Even immigration policy was aimed at industrialization. I would say that laissez-faire is a myth because it has never really been tried. Has there ever been a nation that industrialized through laissez-faire? Certainly not, and the growth of China clearly demonstrates why.

“The key is, what then should be done?” The further question is “for whom?”. Are we trying to make life better for the current citizens of the city, or for some theoretical future “more productive” citizens? The quick and easy answer is “both”, but it just doesn’t work that way. I’m sure you’ve seen the several articles lately about Google/Facebook/eBay tech workers “taking over” nabes in San Fran and riding the company-provided luxury bus to the suburban office, driving out the previous (less prosperous) residents of the city. And you are certainly familiar with the many New Yorkers (or likely ex-New Yorkers) decrying how the city has become a playground for the rich, far too expensive for any person of normal means. Many of the rebounding cities in this country appear to have taken Bertolt Brecht’s old advice: “dissolve the people and elect another”. Brecht was being a wiseguy; Daley, Bloomberg, Magaziner and their like seem to take it seriously.

I don’t know much about sociopolitical conditions in RI in the Eighties, but I doubt there were large numbers of laissez-faire capitalists among the polity. Maybe the folks there, after hearing some details of this futuristic plan, realized they had little place in it. Why would they vote for it, if that was the case? Or maybe they just felt their political class was corrupt and would just steal most of the money anyway. I can’t believe most people were voting on ideological grounds.

This doesn’t mean you’re wrong about market-oriented theories. But I think we first need to ask “who are we helping with this development policy”? If it isn’t the current citizens, then why not, and who? Seems like an obvious question, but I rarely see urbanists of the “econ development/creative class” stripe answer it. And if the proposal is “eds/meds and tech” then you’re crafting a solution that will mainly benefit a certain elite group, with a bit of spillover for everyone else. On the other hand, if your belief is that “churn” and labor mobility are keys to prosperity, well OK, I could possibly be convinced of that. But, in the interests of ‘good faith argument’ and all, let’s get that straight up front if we can.

(disclaimer: I am a “tech worker”, though a sort of old one, but could possibly benefit from a “tech-oriented” jobs policy).

I don’t see any details on what Greenhouse Compact meant by “Industrial Policy”. Should we presume that it was simply a rehash of government subsidizing favored companies in the hope that RI would turn into a mini-Silicon Valley, or at least a mini-Boston?

Does anyone seriously think that some bureaucrats with subsidies would have done more than waste funds that RI could better use to meet its pensions obligations? (to RI’s credit, they are ahead of many places in grappling with this problem)

I find this form of “subsidize the rich” policy to be particularly grating – money is taken from resident’s sales taxes and given to a bunch of rich (or potentially soon to be rich) people. If the investment works out, the rich get richer and the taxpayers get to watch them enjoy their money while they pay higher rents. If the investment doesn’t work out, the failed recipients go on to the next project, and the taxpayers are all a little poorer. Another version of “heads, the rich-and-well-connected win; tails, the taxpayers lose”.

The last thing RI (or anywhere) needs is a policy that explicitly tries to increase income inequality, especially one funded by sales taxes mostly paid by the non-rich.

Derek, that was only one plank. Keep in mind, the plan was developed in 1983 in a very different income inequality context and in which tech companies and such often became large, broader based employers that included manufacturing operations.

Aaron, isn’t at least one answer highly focussed public / private partnerships? I’m thinking of the Indianapolis’ amateur sports capital strategy from 30+ years ago, which couldn’t have succeeded without investment and cooperation from both the private sector and governments. In other words, this isn’t just an either / or (government vs. private sector) issues. Smart place leverage assets and resources regardless of who owns them.

Also, remember that at least at the municipal level, the public is responsible for 25% — 40% of the land via roadway rights-of-way, parks and public institutions such as schools and libraries. The quality of these spaces and the performance of the institutions has a huge impact on potential investors and residents. Their quality may not be a direct focus of economic development strategies, but they are inextricably linked.

Rhode Island has a tiny population. It is pathetic it cannot lift itself up.

Progressive Era voter approval reform knocked down another good idea. Not first time good plan failed on a public vote. In city county consolidation effort a couple of good plans failed, then similar forms were implemented elsewhere (without recourse to a vote for approval) where other regions prospered while these which rejected it slumped and continue to decline over time.

There is corruption even in absence of an “industrial policy”. Age of financialization appears to foster even bigger levels of corruption and misallocations of capital.

In the days of automation, industrialization is no longer the employer it has been. Best states can do is invest in human capital and encourage people to be entrepreneurial so as not to depend on an employer.
You might find this of interest:

James, the critics of industrial policy explicitly say that the state should invest in health, education, and infrastructure instead of propping up specific industries. These are improvements that help more or less the entire population, and give the population more options. Economic growth follows because people with better education can hold more specialized jobs and do them more efficiently, healthier people are not going to drop dead suddenly because of whooping cough, and so on. Environmental policy should be viewed in this format: it’s about making sure people don’t die of lung cancer, asthma, and contaminated water, and on a global level that the number of climate refugees is kept to a reasonable minimum.

Of course, some of these can also double as industrial policy. For example, higher fuel efficiency standards for cars help industries that produce lighter construction materials like aluminum. For a more famous example, the construction of the highway network helped the auto and oil industries. This should be viewed as a side effect, not the main goal, even though the industries that benefit lobby for more and can even hijack the relevant government departments – e.g. by the middle of the 20th century the US built roads to employ construction workers and help the big automakers, and in the late 20th century Malaysia built roads to create domestic demand for its state-owned car industry (and is one of the most motorized middle-income countries today).

The important thing is to engage in good social policy without letting companies that happen to benefit drive future policy. So this means that if a solar cell manufacturer happens to support your program to put rooftop solar panels on people’s houses then it’s great, but it shouldn’t make you stop engaging in parallel policies such as subsidizing the installation of better home insulation and similar conservation measures.

Re the Erie Canal, the benefit is that although it greatly reduced shipping costs, New York did not let the shipping companies hijack its transportation policy. Once railroads came along, it authorized their construction, even parallel to the Erie Canal. The railroads parallel to the canal were prohibited from carrying freight, but in the early days of the railroad the primary revenue source turned out to be passengers.

This is a bit of a tangent, but during the 19th century the US government exercised a health tariff to support specific industries. Japan did that during the 60s. China today.

I think that maybe you object to helping one specific industry or one specific business. Is this an accurate assessment?

There is a theory that strong central governments go hand in hand with industrialization: one doesn’t exist without the other. And the pushback against big government is a result of America’s movement past the industrial economy and into the information economy.

It actually reminds me of your criticism of tea party politicians who cut sweetheart deals with business and industry. Many of these places are still going through the industrial revolution. Lexington KY keeps adding factories while Chicago keeps shedding them. And Chicago, in turn, adds start ups.

I would also note that many opponents of industrial policy are opposed to health, education, infrastructure, etc 😉

Downloading and reading the executive summary, it makes for a pretty interesting read. The depth of the commission study of business closings and job losses during the prior decade is amazing – essentially evalauating and determining the causes for every plant closure. Rhode Island’s status at the time of ranking 50th among US states in value added per worker and 48th in average manufacturing wage was certainly appropriate cause for attempting some measures to enhance job creation, improve the business climate, and improve perceptions (the state seemed to be in a worst of all possible worlds scenario in having a high cost reputation while having average wages that ranked 48th highest among states). Overall, seems to me like it was a balanced approach based on detailed analysis and facts.

I found it interesting that one of the findings was that “management inefficiency” which was described as “lack of business acumen, overexpansion, over leverage, or inability of new management to successfully operate a company) led to the majority of firm failures and job losses, as well as an inability of firms of owners to find buyers. Not the usual boogie men (need for right-to-work laws, business tax cuts, etc.) and also things that a good local economic development agency can provide through economic gardening” or other programs. For those that do not read the linked executive summary, the “greenhouse compact” was not tied in any way to environmental policy, green industry, etc. but was referencing one of the key proposals to create independent not-for-profit research institutios that would conduct research and consult for government and industry – focused on key technology areas in which Rhode Island has some inherent potential compeitive advantage.

James: this is sort of what I’m saying. Tariffs are also a problem in that they discourage trade and are often targeted toward specific industries, although if a country can levy a general tariff and not be retaliated against this will usually help its economy (see e.g. Japan from the 1950s to the 70s and Korea from the 60s to the 90s). A better manipulation strategy would be keeping the currency undervalued, or at least preventing it from becoming overvalued, since this boosts exports; a poor area needs to export rather than rely on an internal market, which is just as true of the American South as of China.

19th century US tariffs did not help the economy, though. The US did not have faster economic growth from 1812 to 1846 and from 1861 to 1929 than before 1812 (when tariffs were low and existed only as a revenue-raising measure in the age before income taxes) or between 1846 and 1860 (when tariffs were low as per Polk’s free trade policy). Industrial captains liked the tariffs because they liked having less competition, but the rest of the country didn’t.

It’s this disconnect between what’s good for CEOs and what’s good for the rest of society that makes me wary of proposals to improve the business climate by creating specific industry clusters. If all you’re doing is shifting development from one kind of industry to another, then you’ve gained nothing (unless the industry you’re attacking creates problems independently of its economic value, such as pollution). Improvements in productivity come from policies that don’t try to guess where the comparative advantage is – in the 1950s Japan had no idea that oil prices would rise in the 1970s and its small cars would suddenly be more popular than American gas guzzlers.

Providence is paying smartphone app developers to live in the city while they’re bouncing from project to project, with no real vision except “we want to be successful” and no attachment to the city that would make them stay if they were successful.

The problem is that it also reinforces rather than undermines the power relationships in the area. In a Rhode Island that was equally wont to engage in this kind of policy but for some reason had a government dominated by geeks, the state government would be luring in filmmakers who promise to film Lovecraftian horror. Providence certainly has that competitive advantage. It’s useless, but no more useless than paying app developers. But app developers are currently Hot Stuff and politicians are convinced that tech is the next best thing and everyone should party like it’s 1999, so they’re fellating that crowd.

An uglier way to express what you note about the politics of industrialization is such that in the early stages politicians fellate factory owners, and in later stages factories are no longer interesting so they find the next thing to chase. In American cities today tends to be software and biotech (and somehow none of this translates to demands for more government funding of basic scientific research).

Going on a tangent again, I think the connection between the information economy and small government goes in the other direction. It’s not that the information economy leads to less government involvement – in the US and the UK that trend began in the early 1980s, when Microsoft was still a very small firm. It’s the reverse: once government is cut to the point of being unable to execute or oversee major infrastructure projects, the industries that thrive are the ones that have very low capital requirements and yet large enough network effects to be able to grow larger than a grocery store chain. To defend the American way, people start to overrate the importance of those industries that can succeed in this environment, which happen to produce software more than, say, electronics. Hence, information economy. On the international level the same happens in India (where infrastructure is so terrible it’s easiest to succeed by doing something that requires little of it, i.e. selling software to people in countries with better infrastructure) and Israel (where the business culture is extremely risk-taking and incapable of large-scale cooperation, both of which favor tech startups), and not surprisingly Americans who write about global development overrate both of those countries as hotbeds of innovation, and Israelis treat Indians as economic kindred spirits rather than just expedient allies against the Muslim world.

Alon, that’s a provocative though. I think it certainly explains why India has skewed towards tech and BPO. On the other hand, there are many places with poor infrastructure and government investment that did not see knowledge industry booms. India also has a tradition of English proficiency, technical education, and Anglo-influenced culture and legal traditions, plus a large diaspora community already working in tech. (See “The New Argonauts” for pretty compelling analysis of this). Israel is an interesting case, but also a large diaspora, including lots of Russian Jews with hard core tech and math expertise. And the military seems to play a role.

Also, Seattle and San Francisco are in places that have had pretty well-provided government services. The community colleges were key for a long time when chip and other manufacturing was still done there.

But I think this would make a fascination study project. It certainly suggests vectors whereby economies would develop in various directions.

About Aaron M. Renn

Aaron M. Renn is a Senior Fellow at the Manhattan Institute and an opinion-leading urban analyst, writer, and speaker on a mission to help America’s cities thrive and find sustainable success in the 21st century. (Photo Credit: Daniel Axler)